Canadian financial institutions will soon be mandated to assess the human rights consequences associated with their project finance loans. The requirement is arising through revisions to the Equator Principles (EP), a series of 10 principles that guide financial institutions engaged in project finance for large infrastructure and industrial projects. Most of Canada's major banks, as well as Export Development Canada and Manulife, are EP members, also known as Equator Principle Financial Institutions (EPFIs).
A revised draft of the EP was released for consultation in late June (EP IV). The revisions require EPFIs and their clients to place greater emphasis on assessing the potential impacts projects may have on human rights, Indigenous peoples, and climate change as a condition for project finance.
EP IV will also impact more clients and projects than previous EP. EP IV applies to projects with a threshold loan value of $50 million, down from $100 million. Project refinance and project-related acquisition financing are also included for the first time.
EPFI project finance agreements include covenants that require compliance with the EP. Clients will bear the onus to demonstrate that a project will not have adverse impacts in target areas, or that adverse impacts can be sufficiently mitigated. The draft text of EP IV permits EPFIs to call an event of default if clients fail to meet their environmental and social covenants.
Companies whose business relates to infrastructure and industrial projects must take note of these developments in order to maintain secure access to project finance.
Changes go beyond current Canadian law
The draft EP IV imposes standards that go beyond current Canadian legal obligations in relation to assessing impacts on human rights and Indigenous peoples. This means the EP will play a larger factor in domestic project finance considerations than previously.
On human rights, EP IV will require EPFIs and their borrowers to assess the human rights impacts projects have on individuals and communities more broadly. This goes beyond adhering to the company's Canadian labour and human rights obligations to its own workers.
On Indigenous peoples, EP IV will require EPFIs and clients to operate according to concept of free, prior, and informed consent (FPIC), the international standard for consultation with Indigenous populations pursuant to the UN Declaration on the Rights of Indigenous Peoples. This goes beyond the Canadian legal requirement of the duty to consult (the Canadian government cites FPIC as a principle that guides its approach to reconciliation).
EP IV adds the requirement for EPFIs to fulfill their responsibility under the UN Guiding Principles on Business and Human Rights (UNGPs). The UNGPs require businesses not to cause, contribute to, or be directly linked to human rights abuses.
Providing loans to support projects that lead to severe adverse human rights abuses contravenes the UNGPs. The obligation to refrain from providing such loans will also influence EPFI project finance decisions.
Potential clients will have to engage in human rights impact assessments to satisfy an EPFI that provision of project finance will not bring the EPFI offside its UNGP obligations (this is in addition to the client's own obligations under the UNGPs). The EPFI can also conduct its own impact assessment as part of its transaction due diligence.
Enhanced recognition of Indigenous rights is a major feature of EP IV. The current draft proposes two options for how to implement FPIC.
One approach states clients "are expected to engage in meaningful consultation...with the goal of achieving FPIC." This leaves open the possibility that projects could still proceed if impacted Indigenous communities do not provide FPIC.
A second approach makes obtaining FPIC a mandatory requirement. It states, "The client must demonstrate, to the EPFIs satisfaction, that the FPIC of the Indigenous peoples affected by Project is obtained."
The approach that emerges in the final EP IV will have a significant impact on how clients and EPFIs conduct consultations.
Another change in EP IV is a requirement to include a climate change assessment for certain projects. Thresholds for this requirement relate to the risk of adverse environmental effects and a project's level of combined scope 1 and scope 2 emissions. Scope 1 emissions are those emissions from sources owned or controlled by a company. Scope 2 emissions are those emissions resulting from the generation of a company's purchased electricity.
Liability for human rights impacts?
Membership in the EP evidences an EPFI's understanding that it cannot finance major projects without assessing the impacts those projects have on others, in Canada and abroad.
This does not mean EPFIs could be automatically liable for human rights violations that occur in their funded projects. However, concerns around liability for human rights violations are real. Four civil actions currently before Canadian courts claim a Canadian corporation should be liable for human rights violations that occurred in its supply chain (the cases all concern acts committed abroad). Legal efforts by the companies to have the cases dismissed have so far failed. A fifth case was recently settled.
Canadian EPFIs that do not take their EP obligations seriously and do not engage in human rights impact assessments or operate in accordance with FPIC risk being accused of failing to abide by best practices they themselves have ascribed to, thus setting up potential tort claims.
Preparing for EP IV
EP IV is expected to come into force by the end of 2019. This leaves businesses engaged in large infrastructure and industrial projects with a few more months to develop internal processes that will enable them to meet requirements imposed through the EP. EPFIs and potentially impacted project borrowers should:
- Implement processes to carry out the required due diligence for determining potential adverse impacts of projects; and
- Familiarize themselves with the expectations established by the UNGPs, and other relevant instruments such as the OECD Guidelines for Multinational Enterprises and the International Finance Corporation Performance Standards.
Businesses already taking steps to enhance their human and environmental performance in line with those instruments can align this process to the new EP. Businesses that are not yet examining human and environmental impacts in line with these best practices can use the EP IV draft as an opportunity to initiate a process to comply with the new project financing requirements.
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